Economic incentive instruments

Research has been conducted in evaluating the effectiveness of economic incentive instruments. Specifically, the pollution charge policy in China has been quantitatively evaluated and is found to be an effective policy instrument. However, it is suggested that the charge rate should be increased in order to get more benefits from the policy.

Reduction of carbon emissions from deforestation and forest degradation has been identified as a cost effective element of the post-Kyoto strategy to achieve long-term climate objectives. Its success depends primarily on the design and implementation of a financial mechanism that provides land-holders sufficient incentives to participate in such scheme. This paper proposes self-enforcing contracts (relational contracts) as a potential solution for the constraints in formal contract enforcement derived from the stylized facts of the implementation because relational contracting relies upon mutual private self-enforcement in a repeated transaction framework. The paper derives an opportunity cost function for land use and characterizes the optimal self-enforcing contract as well as provide the parameters under which private enforcement is sustainable. The optimal payment scheme suggests that all payments should be made contingent on the carbon offsets delivered, that is, at the end of the contracting period. Thus, the optimal contract does not observe any ex ante payment. Self-enforcement is more difficult to sustain the higher the opportunity cost of forest conservation is relative to the value of the carbon offsets from the contract. Necessary extensions to the relational contracting model are also discussed

The success of reducing carbon emissions from deforestation and forest degradation depends on the design of an effective financial mechanism that provides landholders sufficient incentives to participate and provide additional and permanent carbon offsets. This paper proposes self-enforcing contracts as a potential solution for the constraints in formal contract enforcement derived from the stylized facts of reducing emissions from deforestation and forest degradation implementation in developing countries. It characterizes the optimal self-enforcing contract and provides the parameters under which private enforcement is sustainable when the seller type that is, the opportunity cost of the land, is private information. The optimal contract suggests that the seller with low opportunity cost receives a positive enforceable payment equivalent to the information rents required for self-selection, in contrast to when the buyer knows the seller type in which case all payments should be made contingent on additional forest conservation. When the buyer does not know the seller type, a first-best self-enforcing contract can be implemented if forest conservation is sufficiently productive. If the gains from forest conservation are small, self-enforcing contracts may induce some carbon sequestration by some or all seller types, depending on the value of the shared gains of the relationship.

The authors investigate two aspects of China's pollution levy system, which was first implemented about 20 years ago. First, they analyze what determines differences in enforcement of the pollution levy in various urban areas. They find that collection of the otherwise uniform pollution levy is sensitive to differences in economic development and environmental quality. Air and water pollution levies are higher in areas that are heavily polluted. Second, they analyze the impact of pollution charges on industry's environmental performance, in terms of the pollution intensity of process production and the degree of end-of-pipe abatement for both water pollution and air pollution. Econometric analysis shows that plants respond strongly to the levy by either abating air pollution in the production process or providing end-of-pipe treatment for water pollution.

“Equilibrium Pollution and Economic Development in China,” Hua Wang and David Wheeler, Environment and Development Economics 8(3), 2003.

This paper develops and estimates a structural equilibrium pollution model, in which the price and quantity of industrial pollution are jointly determined by the intersection of environmental demand and supply functions. The industrial environmental demand function relates industrial pollution intensity to the local price of pollution, while controlling for characteristics such as sector, scale, and ownership. The local environmental supply function specifies the pollution price imposed by the host community as pollution rises. The model provides a good fit to available data on provincial variations in China s pollution levy, or industrial emissions charge. Our results also suggest that Chinese industry has reduced emissions significantly in response to the levy.

This paper empirically tests pollution abatement efforts of Chinese industries in response to pollution regulations, especially the pollution charge instrument practiced in China for about 20 years. The impacts of pollution regulation on abatement expenditures are examined for one thousand large and medium Chinese industrial polluters. The results show that plant-level expenditures on end-of-pipe wastewater treatment are strongly responsive to the pollution charges. The estimated elasticities of operation cost and new investment with respect to pollution price are 65 and 27%, respectively. Other command-and-control regulatory approaches, however, are not found to have systematic and significant impacts on abatement expenditures.